In Transit. From Classic Research to Modern Innovation Policy

Germany can look back on considerable improvements in the area of public and private expenditure for research and development, advancing the excellence and attractiveness of its research institutions and modernising its economy. At the same time, the challenges it faces have continued to grow in recent years – especially due to new competitors emerging in the course of the digital transformation. German research and innovation policy therefore needs to continuously develop itself further over the next decade.

During the post-war period, many states established research systems oriented towards the needs of the science sector. Since then, emphases have shifted considerably in favour of innovation, towards the conversion of new knowledge into value creation potential. A look back at the years since 2005 shows a primarily positive development for Germany. This article starts by observing science systems, knowledge transfer, innovation ­in established companies, entrepreneurial innovation, and governance of the system. Additionally, Germany’s position in mastering the digital transformation is elucidated.

The Reinforced International Significance of the German Science System

The higher education sector has seen a considerable improvement in both personnel and financial resources. The number of scientific and artistic employees has risen by over sixty per cent since 2005. Findings from the scientific sector can become an essential source of innovation, employment, economic growth, as well as social and cultural developments. As a direct result of the Higher Education Pact between the Federal Government and the Federal States from 2007, higher education institutions also received more basic funding. This has risen nominally by over forty per cent since 2005. Above all, however, third-party funding as financing has gained in significance. In 2005, for every euro of basic funding, the institutions received twenty-three cents of funding from third parties; by 2014, this number had risen to thirty-two cents. Projects from third-party funding promote healthy competition among researchers and research institutions; however, the strong growth in third-party financing has also been accompanied by problematic changes to teaching: despite the higher absolute number of employees, the ratio of students to scientific and artistic personnel in positions without third-party funding has even dropped somewhat. In addition, universities still have to largely fund the so-called overhead costs of third-party projects using their basic funding. This is restricting financial freedom in teaching.

The policy measure within the higher education sector that has probably garnered the most attention in the public eye in recent years is the Excellence Initiative. The Federal Government and Federal States agreed on a first funding period from 2006 to 2011 with a budget of 1.9 billion euro. For the following period from 2011 to 2017, 2.7 billion euro were budgeted in a second agreement in 2009. The objective of the initiative was, on the one hand, to vastly improve the quality of Germany’s higher education and knowledge. On the other hand, the Excellence Initiative was primarily aimed at making top research more visible on an international level. In 2016, the Federal Government and Federal States agreed on an Excellence Strategy, an unlimited follow-up programme for the Excellence Imitative. The agreement was substantiated by positive developments in the Federal framework conditions over the last few years. The amendment to Article 91b of the German Constitution as agreed by the Bundestag and Bundesrat gives the government new opportunities for financing universities. However, this option has not yet been put to use.

In addition to measures in the higher education sector, the research and innovation policy of recent years has also aimed at improving the international competitiveness of non-university research institutions. The Pact for Research and Innovation between the Federal Government, Federal States, German Research Foundation, Fraunhofer Society, Helmholtz Association, Leibniz Association, and Max Planck Society concluded in 2005 and continued in 2014 strives to strengthen the international network of scientific organisations, as well as the exchange between science, economy, and society. For this purpose, the scientific organisations received assurance that their budgets for the years 2006 to 2010, 2011 to 2015, and 2016 to 2020 would each year grow by three per cent, five per cent, and again three per cent, respectively.

Programmes for the Transfer of Research Findings – Still No Resounding Successes

If research findings can be successfully converted into applications of economic or socio-cultural value, findings from the scientific sector could become an essential source of innovation, employment, economic growth, as well as social and cultural developments. In terms of research and development, Germany is dependent on a few core industries. For example, the automotive industry accounts for over a third of internal research and development spending. In the past few years, policy has established a range of measures with the purpose of successfully establishing this transfer. These programmes are aimed at reducing the uncertainty in research finding applicability and promoting the cooperation of economy and science in the development of joint utilisation strategies. The Federal Ministry for Economic Affairs and Energy prioritises the transfer to the mid-sized sector and founding activities in the scientific sector, for example through the ‘EXIST – Business Start-up Grant’ programme.

As a further mechanism to transfer scientific findings to entrepreneurial practice, the Federal Government and States have initiated a large number of clusters – “geographic concentrations of interconnected companies and institutions in a particular field” – in the last twenty years. The material and immaterial resources available in the cluster are intended to positively impact the inventive, innovative, and economic performance of individual participants. As the number of established clusters grows, the beneficial effects of further funding could weaken increasingly; therefore, significantly less weight should be placed on cluster funding in the future.

Innovation in Established Companies

The share of expenditure of the gross domestic prod- uct on domestic research and development has noticeably increased in Germany since 2005 – from under 2.5 to around 3 per cent. Private companies finance close to two-thirds of all research and development. Most recently, the state financed just 3.3 per cent of all research and development within companies; primarily funding specific research and development projects based on application and approval procedures, as well as through government contracts with companies. Prominent funding instruments are the Central Innovation Programme Mittelstand (ZIM) and Industrial Joint ­Research (IGF).

Despite the increase in research and development intensity, there are also grounds for concern. In terms of research and development, Germany is dependent on a few core industries. For example, the automotive industry accounts for over a third of internal research and development spending. Foreign companies’ research and development projects in Germany also primarily fall within these core industries. Around sixty-one per cent of employees working in companies in Germany work in so-called small and medium-sized enterprises (SME) with fewer than 250 employees. While German SMEs enjoy a reputation of being highly innovative, they are actually very heterogeneous when it comes to their innovative activities. In the period between 2013 and 2015, just 42.6 per cent of SMEs actively researched or introduced product or process innovations. German SMEs lead the pack of European companies when it comes to the frequency of product or process innovation; however, in terms of patent intensity and revenue share of new products, they are merely average. The innovation intensity of SMEs, already low in European comparison, and with it innovation expenditure in relation to revenue, has been following a downward trend since 2006. SMEs view excessive innovation costs and disproportionately high economic risks, as well as the lack of suitable technical staff and internal sources of funding, as the most significant obstacles to innovation. In particular, demographic developments and the associated lack of specialised workers are posing a serious challenge to the innovative activities of German companies.

Low Number of Start-ups

Start-ups play a significant role in the competitiveness of a country. This is why policy promotes the founding of innovative companies through a range of programmes. The aforementioned EXIST programme is aimed at scientific business start-ups. The High-Tech Gründerfonds, created as a public-private partnership, has invested in cross-sector, technology-oriented start-ups since 2005. The “GO-Bio – Founding Initiative Biotechnology” was also launched in 2005. Despite these efforts, the number of start-ups in Germany, especially knowledge-based start-ups, remains low in an international comparison. Financing during the founding and growth phase represents a key challenge for all start- ups. This especially applies in Germany. Experts primarily blame a lack of scholastic and extra-scholastic start-up training as an institutional reason for this. Universities are offering more entrepreneurial training; however, predominantly within economic rather than natural sciences and engineering study programmes. There are also administrative obstacles facing German start-ups. A ranking of countries by administrative costs for start-ups, performed by the World Bank, puts Germany as low as 113th of 190 countries assessed. Financing during the founding and growth phase represents a key challenge for all start-ups. This especially applies in Germany. The market for venture capital is less developed than in other (also European) countries. Capital shortfalls are slowing the growth rate of many promising start-ups. In the past few years, the Federal Government has initiated several improvements aimed at venture capital investment, for example the funding programme “INVEST – Venture Capital Grant” in 2013. In 2016, further agreements were made to more loosely regulate the fiscal treatment of losses carried forward, which was up to then consistently criticised as a hinderance to the venture capital industry in Germany.

Governance – from Existing in Parallel to Genuine Coordination?

Research and innovation have the potential to offer decisive solutions to major societal challenges such as climate change and demographic developments. Agreements that span different policy fields and levels are urgently needed. The coordination between research and innovation policy and other policy fields is increasingly gaining in significance. Since 2006, the Federal Government has striven to coordinate research and innovation funding across departments through its so-called High-tech Strategy. This now constitutes a proven framework for comprehensive innovation strategy. So far, experiences have been mostly positive. However, the state can do more than just determine an effective cross-departmental innovation strategy and set framework conditions conductive to innovation. Public procurement offers the opportunity for active involvement, as a driver of innovation. With an annual public procurement budget that, according to conservative estimates, amounts to approx. 350 billion euro, state innovation policy could, on the demand side, play an important role for the formation and development of innovation-oriented markets. To name an example: the Commission of Experts for Research and Innovation wants to, in part, focus public procurement expenditures less on established solutions, and more on innovative products and services. The most important associated political initiative took place in 2013, when a consulting centre was founded that advises responsible authorities at the federal, regional, and communal level on innovative procurement, as well as communicate successful practical examples.

Political decision-makers should be informed on the success of measures in research and innovation policy. To support this ambition, evaluations or success checks are now performed for many of these measures. So far, however, a transparent and comparative overview of the evaluations carried out is lacking at the national and international level, and few examples of good practice have been identified in Germany. Furthermore, a lack of transparency impedes the scientific validity of the evaluation studies.

An Interim Balance

Innovation systems are highly path-dependent. From a historical perspective, Germany has specialised in incremental innovation within established companies in a few industries. German actors have, until now, been remarkably successful with this specialisation. These accomplishments have directed the view away from the weaknesses in the entrepreneurial sector. However, insufficient support of start-ups, shortfalls in financing tools for young companies, and a lack of focus on digital technologies are currently emerging as a weakness against the backdrop of digital transformation.

A Need to Catch-up with Digital Transformation

If the digital economy is differentiated into the ‘classic’ information and communication technology sector (ICT) and the Internet economy, ICT companies still dominate in terms of market capitalisation. Innovation systems are highly path-dependent. From a historical perspective, Germany has specialised in incremental innovation within established companies in a few industries. The market capitalisation of the Internet economy is, however, growing at a much higher rate. The entire digital economy is clearly dominated by US companies: in 2016, for example, US companies were worth 1,686 billion euro, approximately twenty times as much as the entire German (thirty-five billion euro), Swedish (four billion euro), and South Korean (forty-three billion euro) Internet economies put together.Since the turn of the millennium, young companies in the Internet industry such as Facebook, Alphabet, Twitter, and LinkedIn have grown rapidly and today exceed the market capitalisation of many long-­established information and communication technology corporations. The digital shift of the economy and society is substantially advanced through new digital business models. Established companies in traditional sectors are increasingly challenged by new Internet companies. In the process, the significance of services, in comparison with pure production, is on the rise. Certainly, German companies are aware of the challenges posed by the digital transformation. However, surveys show that small and medium-sized companies are above all experiencing difficulties in designing and implementing new digital business models.

Germany certainly boasts real strengths in digital technology – primarily in technology-oriented research. The actual problems lie in Internet-based research, as well as in the transfer of scientific results to applications. The strength of Germany’s highly developed, production technology-based information technology is internationally acknowledged; however, this specialisation will no longer be sufficient in the future, with the digital transformation affecting all industries and areas of life.

The digital transformation also offers opportunities to improve the quality and scope of state services. Services provided by public authorities and administrative processes can be digitalised and offered online, as part of the so-called ‘E-Government’. In addition, demand for E-Government IT solutions can drive innovation in the ICT and Internet sector. The E-Government Development Index of the United Nations shows that Germany remains underdeveloped, only providing incomplete, and inconsistently digital, services. Furthermore, the user-friendliness of digital services currently offered by public authorities often leaves much to be desired. The data gathered through the digitalisation of public administration can basically be made available, under consideration of data protection regulations, as open government data for the development of new services and innovative business models. In Germany, however, such standardised provision through well-structured access is currently still lacking.

Continuous Development, but not in All Areas

The German innovation system has developed considerably over the past years. The objective of spending three per cent of the gross domestic product on research and development has been achieved. Germany’s science system has been clearly strengthened through the Excellence Initiative and Excellence Strategy, the Higher Education Pact, and the Pact for Research and Innovation. Although Germany still lags behind other countries when it comes to the likelyhood and propensity of a person to launch a start-up. German research and innovation policy has, at the very least, initiated sensible improvements in framework conditions for start-ups and venture capital. These are, however, not yet sufficient and these objectives must be consistently further pursued, primarily in digital technologies and business models. Tremendous backlogs still exist, despite individual positive developments. German state policy has not yet demonstrated the required agility to master the digital transformation.

In the following, individual measures will be outlined which should be prioritised for the further development of the German research and innovation system.

Further Expansion of the Science system

Currently, German universities are structurally underfinanced. The Federal States will therefore have to significantly improve the basic financing of universities. In teaching, the Federal Government should further support States by continuing the Higher Education Pact. In international competition, the attractiveness of German universities can be further increased by raising the number of professorships with permanent contracts and upstream tenure-track paths. In addition to investments in general university infrastructure, which is often in need of renovation, the Federal Government and the States should launch special investment programmes to bring infrastructure up to speed with the state-of-the-art and enable it to meet the requirements of the digital transformation. The universities should also receive more freedom to implement modern organisational structures and differentiate their offers based on their strengths. Aside from higher education institutes, non-university research institutions must be strengthened through a continuation of the Pact for Research and Innovation.

More Effective Transfer of Scientific Results to Applications

The transfer of scientific findings to corporate and social applications can, among other things, be promoted through improved legal framework conditions. For example, conflicts between the scientific and economic objectives of research results utilisation can be minimised by introducing a grace period in patent law. This would allow researchers to apply for patent protection for their inventions for a specific period of time despite previous scientific publications.

Promoting Radical Innovations

While the German innovation system successfully produces incremental innovations on the basis of existing technologies, products, and services, it is usually foreign companies that introduce completely new offers and business models, so-called radical innovations, to the market. That is why research and innovation policy needs to further promote the implementation of pioneering and daring research and development projects which address the challenges of our time and yield entirely new product concepts, technical solutions, or services. This could for instance include the establishment of an agency for radical innovation. Following the example of the Defense Advanced Research Projects Agency (DARPA) in the US, this agency could advance projects for solving ambitious and risky technological challenges in an independent and entrepreneurial way. It is encouraging that efforts to introduce such an agency are currently being pursued.

Strengthening Innovation Activities in Established Companies

While intensive research and development activities in the automotive industry represent one of Germany’s strengths, additional measures should be taken to diversify research and development activities and to reduce the dependency on this core industry. Above all, the innovation activities of small and medium-sized companies should be strengthened. Established companies in traditional sectors are increasingly challenged by new Internet companies. The many specific funding programmes available are less suited to overcoming financial hurdles; finding and applying for suitable programmes is associated with too much effort for small and medium-sized companies. A fiscal research and development funding programme for small and medium-sized companies would be a key measure. Hidden reserves must be incorporated more aptly to confront shortfalls in specialised workers, which are threatening the innovative ability of companies. Last but not least, framework conditions for intensified professional involvement of women should be further improved.

Measures to Promote Start-ups

Administrative hurdles to founding start-ups should be reduced, for example through a one-stop shop for all information and regulations start-ups need. Start-up training should be started at a much earlier stage. Access to funding for start-ups must be made easier through improved incentives for private investors and attractive fiscal framework conditions.

The State as a Driver of Innovation

The cross-departmental policy coordination pursued by the High-tech Strategy should be continued and further institutionalised. In addition to technological innovations, social innovations should also be increasingly considered in funding policy. The law and practice of public procurement should be adjusted to prioritise innovative offers. Innovation policy should in the future be increasingly further developed on the basis of high-quality and transparent evaluations of policy measures.

Future-oriented Design of the Digital Transformation

In the expansion of its digital infrastructure, Germany should proceed more ambitiously and not only orient itself to the middle of the OECD pack. A long series of political announcements that failed to materialise is straining the credibility of German economic policy. Small and medium-sized companies in particular should be moved into the spotlight of funding measures, to advance digital transformation. In all segments of education and further training, the population must be trained in working with digital technologies. Start-ups have the potential to contribute tremendously to mastering the digital transformation – barriers to their development and growth must be eliminated. The state should use its own services to drive innovation, through E-Government and open data policies. Finally, it must continue to proactively develop the legal framework conditions for the digital economy. Data-based business models raise fundamental questions on the potential ownership of data, copyright and competition law, as well as consumer protection. Citizens’ rights to privacy must be secured without massively restricting innovation through excessive regulations. These considerations are difficult, but they must be addressed urgently from now on.

Research and Innovation in 2030

Germany has the intellectual, creative, and financial resources to be one of the world’s most successful countries of innovation in 2030. Reasonable targets are specified in the 2017 Report of the Commission of Experts ­for Research and Innovation: a share of research and development expenditure amounting to 3.5 per cent of the GDP, high international visibility of leading German universities, excellent framework conditions for venture capital and start-ups, a citizen-friendly and effective E-Government system, and the establishment of new strengths in the field of digital technologies and business models. In all segments of education and further training, the population must be trained in working with digital technologies. Reinforcing existing strengths has not been sufficient for a long time now – new strengths must be discovered and developed. This also requires blunt openness in the estimation of one’s own strengths and weaknesses. Research and development policy cannot succeed if (as was the case quite a few times in the last decade) we only publish positive news. Germany’s innovation system has striking weaknesses. The institutions and departments entrusted with research, innovation, and digitalisation must now prove that they can master the challenges ahead. The most difficult task lies in allowing more agility and flexibility within organisational structures and processes. In his Berlin speech, Roman Herzog said: “In highly technological societies, permanent innovation is an ongoing task! The world is on the move, it won’t wait for Germany.” Germany should not let the world wait – and instead take on a leading role.

Research and Innovation Policy

How We Must Act

  • Policy should send clear signals for the future expansion of Germany as a country of knowledge and innovation. It must strengthen Germany’s competitive position with ongoing digital transformation, by quickly laying the foundations for sustainable digital infrastructure, supporting small and medium-sized companies in shaping the digital change, promoting the growth of start-ups, and creating better conditions for their funding. With efficient, user-­friendly E-Government, the provision of open data, and innovation-­based procurement, the state itself should also become a driver of innovation.
  • German universities and non-university research ­institutions must continue to gain international ­visibility in order to attract scientific talent. The infrastructure of and basic funding for universities must be improved. Especially young people interested in a research career must be offered better career prospects in Germany, for example through a greater number of professorships with permanent contracts. Policy should grant universities greater leeway in the differentiation of their research and teaching profile.
  • The results from research and development efforts must be increasingly transferred to applications in order to generate social benefits. An agency must be founded for radical innovation, to give the impetus for radical new solutions to social and technical challenges in the style of the US DARPA, while developing new forms of value creation in Germany.

Prof. Dietmar Harhoff, Ph.D. (60) is Director of the Max Planck Institute for Innovation and Competition and Honorary Professor at the LMU in Munich. His research work concentrates on innovation and entrepreneurship as well as industrial economics. As the Chairman of the Commission of Experts for Research and Innovation (EFI), he advises the Federal Government on research and innovation policy.

Dr. Alexander Suyer (36) is a Senior Research Fellow at the Max Planck Institute for Innovation and Competition.